Report - IZA Topic Week

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"Institutions and the Employment Relationship" - July 3-7, 2006
To foster international research exchange in its key research areas, IZA has established “topic weeks” which take place at IZA once a year for each program area. During an extensive program of presentations, working groups, discussions and opportunities for close interaction with IZA staff members and guest researchers, the IZA topic weeks extend far beyond the regular workshops and thus offer an ideal platform for productive research visits at IZA.
The First IZA Topic Week on Institutions and the Employment Relationship (as part of the IZA program area “Behavioral and Personnel Economics”) was held at IZA during the week of July 3-7, 2006. A number of renowned labor economists explored how labor market institutions are responding to a changing demand for labor services in this era of increasing globalization.
The topic week showcased new theoretical and empirical research on labor market institutions. Guy Laroque (CREST-INSEE and IZA) presented “Should Low Skilled Work Be Subsidized” (joint with Philippe Choné). This paper revisits the standard optimal taxation result according to which the marginal tax rate should be everywhere non-negative. He showed that this result crucially depends upon the assumption that there is a single dimension of heterogeneity, "skill". When one adds a heterogeneous fixed cost of working, optimal taxation involves subsidizing low skilled work in a number of circumstances. The effectiveness of such a policy requires being able to measure the effect of the tax upon individuals at different parts of the wage distribution.
The measurement issue was addressed by Nicole Fortin (University of British Columbia) in a presentation based upon her paper “Unconditional Quantile Regressions” (joint with Sergio Firpo and Thomas Lemieux). The paper develops a new, empirically tractable technique for studying the effect of institutions. Fortin illustrated the technique with an application to assessing the role of changes in unionization and public sector employment on increasing male wage inequality in the United States and the United Kingdom. She showed that these institutional changes play an important role in explaining the recent increase in the “polarization of income”.
Labor law is also an important policy variable through its effect on turnover costs. Gerd Muehlheusser (University of Bern and IZA) talked about “Regulating Damage Clauses in (Labor) Contracts.” This paper analyzes the incentive to stipulate excessive damage clauses and contract durations in labor contracts due to rent seeking motives between contracting parties vis-à-vis third parties, and among the contracting parties themselves. One can induce a Pareto improvement by imposing an upper bound on the enforceable damages, and can thus explain why courts are reluctant to enforce large penalty clauses. IZA Program Director W. Bentley MacLeod (Columbia University) presented “Reputation, Relationships and the Enforcement of Incomplete Contracts”, a review of the various alternatives to formal contracts that have been studied in the literature, including performance pay and social networks. These two institutions figured prominently in the empirical papers discussed during the IZA Topic Week.
The important issue of employment protection was discussed by David Huffman (IZA) in his presentation “Employment Protection Legislation and Long Term Relationships” (based upon a paper joint with Armin Falk and W. Bentley MacLeod). He showed that laboratory experiments can be a powerful tool for the study of complex labor market institutions, such as employment protection legislation (EPL), where it is extremely difficult, often impossible, to demonstrate a causal link between an observed policy change and changes in labor market performance. In a laboratory setting one can be assured that the treatment (in this case employment protection) is exogenous, allowing the researcher to identify the causal impact of the policy change on labor market performance. This work produced two significant findings: First, consistent with standard economic theory, it was found that EPL in the presence of fixed wage contracts leads to a significant decline in both performance and pay. Surprisingly, it was also found that if firms are allowed to offer contracts with a bonus, this greatly reduced the efficiency loss and resulted in increased pay for workers relative to the non-EPL case.

In his presentation, “Performance Pay and Labor Market Flexibility” (joint with Thomas Lemieux and W. Bentley MacLeod) Daniel Parent (McGill University) showed results on the impact of performance pay on employment using a large panel of workers in the United States. The study finds, consistent with the experimental evidence above, that the use of performance pay is associated with higher incomes and more stable job matches. However, the improved quality of job matches does have another consequence discussed by Thomas Lemieux (University of British Columbia and NBER) in his presentation of the paper “Performance Pay and Wage Inequality” (joint with Daniel Parent and W. Bentley MacLeod). If performance pay results in more able workers receiving more pay, this implies that compensation more accurately reflects worker ability, leading to an increase in wage inequality. Lemieux found that this can potentially explain up to 25% of the increased in wage inequality among males over the 1980s and 90s. Given that labor unions tend to compress the wage distribution by attaching wages to jobs, this result is also consistent with the effect of declining unionization on wage inequality discussed by Nicole Fortin.

The topic week also had a number of presentations reporting new advances in our understanding of how employee performance is related to the way work is organized. It is often hypothesized that worker performance depends upon their perception of how “fairly” they are being treated. The first step in such an exercise to document whether or not there is scientific validity to the concept of a “fair wage”. Eric Verhoogen (Columbia University and IZA) addressed this question in his presentation “Fairness and Freight-Handlers: Local Labor Market Conditions and Wage-Fairness Perceptions” (joint with Stephen Burks and Jeffrey Carpenter). He found evidence of a robust association between the rate of unemployment and the wages of similar workers in the outside market and worker perceptions of wage-fairness: an increase in unemployment or a decrease in outside wages leads workers to perceive their wage to be fairer.
These results show that worker perception of pay is affected by others. The next step is to explore how interactions with others affect performance, the subject of three presentations at the topic week. Takao Kato (Colgate University, Columbia Business School and IZA), a leading expert on the Japanese Economy, discussed his paper “Productivity, Wages and Teams: An Empirical Analysis Using Panel Data,” (joint with Derek Jones). Using high-frequency panel data (daily and weekly) on individual worker performance for all operators at two light manufacturing firms (one in central New York and the other in central China), Kato shows that: (i) membership in offline teams initially enhances individual productivity by about 3% and lowers rejection rates by about 27%; (ii) these improvements are dissipated, typically at 10 to 16% per 100 days in a team; (iii) while initially teams lead to more downtime, these costs diminish over time; (iv) the performance-enhancing effects of team membership are generally greater and more long-lasting for team members who are solicited by management; (v) similar relationships exist for more educated team members; (vi) the team effects tend to be larger for homogeneous teams consisting of workers of similar ability.
Iwan Barankay (University of Essex and IZA) discussed new results from a long term project using field data collected from agricultural workers. His paper “How to Make Friends and Influence Them: Evidence on the Formation of Social Networks and Peer Effects” (joint with Oriana Bandiera and Imran Rasul) shows that by combining a firm's personnel data with individual survey data (collected by the authors), one is able to identify whether a worker’s productivity affects their friends' productivity, and to describe the mechanism behind such peer effects. The study finds that (i) productivity among friends is correlated and that this is not driven by contextual effects or endogenous network formation, (ii) that peer effects only exist when friends are able to observe each other, and that (iii) the form of the peer effect is such that working with friends increases the productivity of low ability workers and decreases the productivity of high ability workers.
Alexandre Mas (University of California, Berkeley and NBER) reported results from his recent paper, “Peers at Work” (joint with Enrico Moretti). They use scanner data from a grocery store checkout to provide a clean measure of worker performance, and find strong evidence of positive productivity spillovers from the introduction of highly productive personnel into a shift. A 10% increase in average co-worker permanent productivity is associated with 1.7% increase in a worker’s effort. Most of this peer effect arises from low productivity workers benefiting from the presence of high productivity workers. Spillovers arose from the low productivity worker being directly in the line-of-sight of the new workers, not vice versa. This is very interesting because in contrast to standard agency models where monitoring the worker is emphasized, the evidence here seems to suggest that there is an encouragement or demonstration effect – when low productivity workers see that higher productivity is possible, they too increase their output, but not vice versa. The authors calculate that by optimally arranging the mix of workers in each shift, this firm could obtain the same amount of sales with approximately 124,000 fewer hours worked each year, or more than a million dollars worth of savings.

David Autor’s (MIT, NBER and IZA) presentation addressed the question “Do Temporary Help Jobs Improve Labor Market Outcomes for Low-Skilled Workers? Evidence from Random Assignments” (joint with Susan N. Houseman). According to this study, moving welfare participants into temporary help jobs boosts their short-term earnings, but these gains are offset by lower earnings, less frequent employment, and potentially higher welfare recidivism over the next one to two years. In contrast, placements in direct-hire jobs raise participant earnings substantially and reduce recidivism both one and two years following placement. Autor showed that encouraging low-skilled workers to take temporary help agency jobs is no more effective and possibly less effective than providing no job placements at all.
Finally, three papers explored different aspects of career development and human capital formation in labor markets. Janet Currie (Columbia University, IZA and NBER) presented "Healthy, Wealthy, and Wise? Health and Human Capital Accumulation Among Children", a paper that bridges the gap between the literature on "health capital" and the labor economics literature on human capital by reviewing the literature about the effects of parents’ socioeconomic status on child health, and subsequent labor market outcomes. The literature suggests that poor health leads to lower school attendance, poorer academic performance, and ultimately lower lifetime income, illustrating the important role that inequality in health plays in the transmission of inequality across generations.
Till von Wachter (Columbia University and IZA) finds that another source of inequality arises from the year in which an individual enters into the labor market. His presentation reported the results from the paper “The Short- and Long-term Effects of Graduation in a Recession: Hysteresis and Heterogeneity in the Market for College Graduates” (joint with Philip Oreopoulos and Andrew Heisz). They conclude that college graduates who enter the labor market during a recession face a loss in income. Although for the average worker the effects of recession at entry fade within 8-10 years, graduates from the bottom of the wage distribution suffer permanent earnings losses.
The first IZA Topic Week within the framework of the IZA research agenda on “Behavioral and Personnel Economics” has shown the high methodological standards and policy relevance of modern labor economics in the field. At the same time it demonstrated that there needs to be continual innovation and learning regarding best labor practices that in turn will enhance the well-being of workers. Furthermore, to produce high-quality policy relevant labor market research, the use of diverse data sources is inevitable: large scale panel data sets, firm-level field data, administrative records provided by both governments and firms, and experimental laboratory data are necessary to complete our understanding of complex labor market processes. In this context, IZA continues its efforts to ensure access to administrative data through the IZA Data Service Center, to produce own comprehensive data sets, and to intensify the cooperation with the Bonn Laboratory for Experimental Economics headed by IZA Director of Research, Armin Falk. These activities are crucial to creating an ever expanding data basis for future labor market research.